CHAPTER 16 TECHNICAL ANALYSIS Answers to Questions 1. The principal contention of technicians is that stock prices move in trends that persist for long periods of time. Because these trends persist they can be detected by analyzing past prices. 2. Technicians expect trends in stock price behavior because they believe that new information that causes a change in the relationship between supply and demand does not come to the market at one point in time - i.e., they contend that some investors get the information before others. Also, they believe that investors react gradually over time to new information. The result is a gradual adjustment of stock prices. 3. The problems encountered when doing a fundamental analysis of financial statements are: (1) much of the information in financial statements is not useful; (2) there are comparability problems for firms using alternative accounting practices; and (3) there are important psychological factors not included in financial statements. Also, with technical analysis it is not necessary to invest until the move to a new equilibrium begins. 4. The disadvantages of technical analysis are: (1) past price patterns may not be repeated in the future; (2) the intense competition of those using the trading rules will render the technique useless; (3) the trading rules require a great deal of subjective judgment; and (4) the values that signal action are constantly changing. 5. The mutual fund cash position of 10 percent is relatively high. This would indicate a bullish market because: (1) the theory of contrary-opinion states that mutual funds are the odd-lot trader of the institutional market and typically make the wrong decision by holding excess cash near a trough when they should be fully invested; and (2) the large cash positions of mutual funds represent potential buying power. 6. Credit balances result when investors sell securities and leave the proceeds with their broker with the intent of reinvesting the funds shortly. Therefore, they can be considered a source of potential buying power. Given this line of reasoning, a decline in credit balances would indicate a decline in potential buying power, which is bearish. Another

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